TAPping Into the Last Round of Industry Consolidation in Global Beer

Most beer industry experts believe that we are approaching the “last round” of major consolidation. The most attractive, sizeable growth asset in beer is SABMiller (“SAB”) given its deep ties into emerging markets and industry leading local beers.

Molson Coors (“TAP”) and SAB have co-operated MillerCoors (“MC”) through a JV since the October 2007. TAP is best suited to benefit from a regulatory-driven asset sale of MillerCoors (“MC”) resulting from of an acquisition of SABMiller by Anheuser Busch (“ABI”). At the current price, the market is pricing in a sub 30% probability of JV consolidation for TAP. This feels low in my view as I believe that the probability of an ABI/SAB merger is greater than 50% and probability of TAP buying the remaining JV is closer to 75%.

Similar to Constellation Brands (STZ), who was able to acquire the remaining slice of Crown Imports JV from AB Inbev 9x, TAP sets up in a comparable position as the US government would most likely not allow ABI (Budweiser) to pick up MillerCoors via SAB acquisition as the former would control the top 3 beer brands in the US (pro-forma close to 2/3rds of the US beer market).

Due to tight rights and remedies via the MC operating agreement, the sale of SAB (or even SAB purchase) puts TAP in a preferential position given their ability to ratchet up ownership to 50% to knock out any parties looking for majority ownership position. Additionally, TAP has a “last look” bid optionality at only a 5% premium.

Given the structural benefits via the agreement, TAP sets up well, in the event SAB is purchased, to scoop up the remaining 58% stake in MC that SAB currently owns. Assuming a 50% probability of a debt financed deal for the JV (at 9x EBITDA in-line with STZ purchase), we arrive at a blended fair value for TAP of $90/share (18% upside, 3x risk/reward).

Recent News
SABMiller (SAB) has been rumored for a number of years as the next takeout target for Anheuser Busch (ABI). It has been almost 6 years since 3G (controlling Brazilian investors at ABI) made a mega-deal (ABI has delivered post Modelo deal).

SAB has dominant distribution across Africa and would be complimentary ABI’s portfolio. Late last year , ABI was rumored to be putting together $122bn financing packaging to buy SABMiller. With interest rates low, organic growth in US beer anemic, and regulators open to mega-deals, 3G-led ABI sees its opportunity to pounce on SAB.

In an attempt to avoid being bought outside of its terms, SABMiller (owned by Santo Domingo family and Altria) made a play for Heineken (“HEIN”). HEIN family rejected the bid. Inbev’s motivation in going after SAB is not for its 58% interest in the #2 US beer player (MillerCoors), but rather to gain exposure to fast growing emerging markets.

Beer Market
At a high level, beer is similar to Tobacco, but with some differences. Beer volumes are shrinking YoY (slower than Tobacco though), but pricing power in beer leads to modest revenue gains while operating efficiencies driven margin enhancement.

The Top 4 Players (42% of global beer)
ABI - Anheuser Busch
SAB – SABMiller
HEIN – Heineken
Carlsberg – CARLB

BUD: The King of Beers (and Deals) ~ SAB Merger Too Hard?
Carlos Brito and the 3G team at Inbev seek out really three items when evaluating acquisitions:

Companies with excess cost to trim
Beers w/ national brands (BUD or Corona)
Majority control ownership (little in terms of complicated JVs)

As evidenced in the chart to the right and given SABs numerous JV structures, SAB does easily fit into an ABI takeover candidate mold at first blush.

SAB is already well run w/ solid margins (below Inbev’s 40% EBITDA margins), prefers dominant local brands in markets and comes with numerous JVs. On top of this, SAB’s is at the top end of the sector (due to fastest growth) and Altria (controls 27% of SAB) has a very low tax basis. Despite the lower synergies opportunity at SAB and higher valuation, Inbev would really benefit from the faster growth markets of SAB. Inbev doesn’t have much room to pay more than a 20% premium on SAB’s stock price, assuming Inbev wants the deal to be EPS neutral in the earlier years.

TAP Valuation
The chance for TAP to buy SAB’s 58% stake in the largest beer market in the world (U.S.) would be highly accretive and transformative deal under most scenarios. The two most important assumptions are 1) price paid for asset and 2) financing mix. Given low interest rates and leverage capacity, it would make most sense for TAP to finance it all with debt. TAP’s balance sheet is currently delivered (1.7x thru 9/30) with a 3% after tax cost of capital (we model 5% rate for incremental debt).

In terms of price paid, TAP is in the best position to get this asset at an attractive price given the operating agreement contract. Similar to this, Constellation brands (STZ) went for 9x EBITDA as In Bev had to divest the JV and the most likely buyer was the incumbent JV manager (STZ). With low rates, the EPS accretion is large as EPS increase 50% assuming 9x paid and 100% debt financed at current TAP rates.

The specific terms w/in the TAP/SAB agreement that help keep the price down, include:

8% ownership step up to 50% removing control premium for any new buyer
First and last bid w/ small premium (5%)
Corporate governance controls upon CoC (TAP can put in new CEO and division heads).

The TAP trade can be viewed in a binary option depending on whether the SAB deal gets done and whether TAP is able to close the JV purchase. Fair value for TAP comes out to $90/share under the following assumptions:

50% probability of a 100% debt-financed deal on 9x for MC stake and 17.5x P/E multiple ($117/share)
50% probability of no-deal on status quo EPS using a pre-deal multiple of 15x ($65/share)
3% synergies target of SAB’s MC stake revenues
5% cost of incremental debt
27% tax rate

Upside Case Price Scenario (Deal) – If TAP buys SAB’s JV interest, the upside case can be achieved ($94-$116/share ~ 21-51% upside) depending on changes to JV price paid, financing mix/interest rate and expected synergies).

Downside (No Deal) – If there is no SAB deal or TAP gets outbid, TAP would most trade back to its pre-M&A speculation multiple (consumer staples & US focused company multiples have risen given the strengthening dollar) of around 15x, which would put most likely trade back to pre-deal speculation levels ($65/share or 16% down). Our DCF fair value for TAP projects a $67/share fair value with NO value for buybacks, meaningful revenue growth (60bps p.a. over next 5 yrs) or acquisitions.

Risk/Reward – Using the below assumptions coupled with the acquisition accretion assumptions below, the market appears to be assuming a 24% probability of a TAP JV purchase resulting in a 3x upside/downside. If we assume 50% probability of deal or no-deal, our blended fair value for TAP is roughly $90/share.

Risks

Faster decline in core beer market
Weaker pricing power than expected
Slowdown in growth of TAP’s craft beers
Overpay for SAB’s MillerCoors JV
ABI doesn’t buy SAB or SAB buys something outside of beer

Disclaimer
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